The future of tax in the UK – Inheritance Tax

With the dust settled on the UK General Election and attention having shifted onto the Autumn Budget, scheduled for 30 October, there is increasing speculation that Inheritance Tax (“IHT”) could be substantially reformed.

Much of the new Labour government’s rhetoric has focussed on the state of public finances, painting a bleak picture of the fiscal position inherited from the Conservative government, citing the need to raise up to £40 billion¹ to close the existing ‘black hole’ and avoid real-terms cuts² in government departmental budgets.

Given the Government’s self-imposed restrictions on raising Income Tax, National Insurance (‘on working people’³) and VAT, combined with the policy objective of reducing the fiscal deficit and national debt⁴, increasing the revenue received from IHT remains one of the only remaining options.

For context it is said we are currently witnessing the single greatest wealth transition in history, with an estimated $84.4 trillion being transferred globally from the baby boomer generation to their heirs by 2045⁵. For the 2024/25 tax year, it has been estimated that IHT will raise £7.5 billion representing a mere 0.7 percent of Government revenues⁶.

J.P. Morgan does not provide tax or legal advice. We therefore recommend that individuals should consult their personal tax advisors in relation to their IHT position.

What is the UK’s current system of Inheritance Tax?

UK domiciled or deemed domiciled individuals are liable to IHT on their worldwide estate.

Individuals who are not domiciled or deemed domiciled in the UK are only subject to IHT on their UK assets (including direct or indirect interests in UK residential property).

The headline rate of IHT is 40% however a multitude of reliefs and/or exemptions are available to ameliorate the burden (see below). Analysis undertaken by the Office of Tax Simplification reflects that estates above £10 million are significant benefactors of these reliefs and therefore the average effective rate payable by these estates is just c.17%⁷. 

Exemptions

There is a tax-free threshold of £325,000 per individual (potentially rising to £650,000 for married couples), below which no IHT is payable.

Individuals who have a net asset estate of less than £2 million may also be entitled to the residence nil rate band of £175,000 (potentially rising to £350,000 for married couples) where the family home will be passed onto their direct descendants (i.e., their children and grandchildren).

For individuals with an estate in excess of £1 million, there are further reliefs and planning opportunities that may be available to mitigate exposure to IHT. Typical options include:

• The spousal exemption: save for specific circumstances gifts to spouses both during lifetime and on death are tax-free with no IHT becoming payable.
• Lifetime Gifts: gifts of up to £3,000 per year can be made with no IHT implications. Individuals can also gift £250 per person per year free from IHT and £5,000 to a child or £2,500 to a grandchild for their wedding or civil ceremony.
  
• Potentially Exempt Transfers (“PET”): gifts, regardless of amount, are not immediately subject to IHT. A charge may only arise where the donor does not survive the gift by seven years or retains an interest in the gifted asset.
  
• Gifts out of surplus income: gifts made as part of a pattern of normal expenditure out of income are outside of the scope of IHT.
• Business Property Relief (“BPR”): shares in unlisted trading businesses (or AIM listed shares) subject to certain conditions should qualify for BPR and therefore fall outside of the scope of IHT.
• Agricultural Property Relief (“APR”): land or pasture used for farming activities may benefit from APR and therefore part of the value may fall outside of the scope of IHT (capped at the agricultural value of the land which may be lower than the market value).
• Pensions: private pensions are typically outside of the scope of IHT and therefore can serve as useful planning vehicles from an IHT perspective.
• Gifts to charities: Outright gifts to UK and EEA charities are exempt from IHT. Where an individual gifts at least 10% of their estate to charity, the rate of IHT payable by that individual’s estate is reduced from 40% to 36%.

Current Speculation

The Institute of Fiscal Studies (“IFS”) in their article entitled ‘Raising revenue from closing inheritance tax loopholes’ ⁸, published in April 2024, suggested a number of options for reforming IHT which could result in an increase in revenue. There is significant overlap between these suggestions and those previously put forward by the Office of Tax Simplification in their second report on IHT⁹ which was published in 2019. 

• Reforms to BPR – AIM listed shares should cease to qualify for BPR. The IFS predict that such a reform could raise more than £1 billion a year.
• Cap to BPR and APR - potential to cap each of the reliefs to £500,000 per person with the unused portion being transferred to the surviving spouse. The IFS predict that the reforms could raise in excess of £1.5 billion a year.
• End tax free passing of pensions – all pension pots, including both defined benefit and defined contribution pensions, should form part of an individual’s taxable estate on death. The IFS predict that this reform could raise in the region of £0.5 billion a year.
• Uplift of Capital Gains Tax (“CGT”) at death ended¹⁰ - assets passed down on death will not benefit from being rebased to current market value but rather the recipients will also inherit the donor’s tax basis.
• Restriction on excess income which may be gifted – introduction of a fixed percentage of income that may be gifted tax-free.

In addition to the IFS report, there has been wider speculation as to additional reforms to IHT which could be introduced by the Labour Government. These include increasing the time limit for making potentially exempt transfers up to 10 years¹¹ and/or abolishing the nil rate band¹². The impact of these reforms has not been costed but is likely to be significant.

What options are available?

For individuals impacted by IHT, it is worthwhile considering what proportion of their wealth is required to fund their existing lifestyle and what proportion of their current and projected wealth that should be considered as part of their ‘legacy’. It is this ‘legacy’ wealth that individuals consider transferring or giving away to the next generation or to the causes they care about. 

For some, the most attractive route for mitigating the IHT exposure on death is through pure consumption. However, for most this is neither possible nor desirable for a variety of commercial and personal reasons including: illiquidity of assets, the desire to safeguard wealth for future generation(s), intergenerational transfer of a family business or property and in some cases the significance of the legacy wealth.

1. Gifting – where it remains the intention to transfer wealth to the next generation, families may consider bringing forward the date of gifting. Whilst the donor may be happy to gift economic interest in the assets, they may use a Family Investment Company or trust to retain control and mitigate the risks of transferring wealth to children who are not ready to receive it.
2. IHT efficient investments –shares in unlisted trading businesses and agricultural land currently benefit from IHT reliefs. Given the current generosity of these reliefs, where commercially acceptable, those with excess wealth may contemplate investing in suitable assets.
3. Life Insurance – individuals may contemplate taking out a life insurance policy which pays out to beneficiaries on their death. This payment should be received by the beneficiaries tax-free and is typically used to settle the IHT liability arising on death.
4. Philanthropy – many individuals harbour philanthropic ambitions. Lifetime gifts to charity do not attract a charge to IHT whilst - where they qualify -can also be used to mitigate an individual’s income tax exposure during their lifetime. It may therefore be tax effective for individuals to make lifetime donations rather than gifting on death.
5. Tax-free lump sum from the pension – given the speculation that an individual’s pension could form part of their taxable estate on death, individuals may contemplate drawing their tax-free lump sum (up to 25% of the amount built up) during their life. This money may then be gifted to the proposed beneficiaries of their estate or used to fund their lifestyle. Advice from a pensions specialist is critical in these circumstances.

Contact your J.P. Morgan Team

Should you wish to discuss this topic in more detail please contact your J.P. Morgan Team.

¹ https://www.reuters.com/markets/europe/uk-finance-minister-reeves-looks-raise-40-billion-pounds-fill-big-gap-budget-2024-10-16

² https://www.bbc.com/news/articles/cj9jdgprv7ko

³ https://labour.org.uk/change/my-plan-for-change/

⁴ https://policyforum.labour.org.uk/commissions/reducing-the-deficit-and-national-debt

⁵ https://www.cerulli.com/press-releases/cerulli-anticipates-84-trillion-in-wealth-transfers-through-2045

⁶ https://obr.uk/forecasts-in-depth/tax-by-tax-spend-by-spend/inheritance-tax/

⁷ https://ifs.org.uk/publications/reforming-inheritance-tax

⁸ https://ifs.org.uk/articles/raising-revenue-closing-inheritance-tax-loopholes

⁹ https://assets.publishing.service.gov.uk/media/5d274fad40f0b61158962af5/Final_Inheritance_Tax_2_report_-_web_copy.pdf

¹⁰ https://ifs.org.uk/news/capital-gains-tax-needs-serious-reform-not-just-more-tweaks

¹¹ https://www.ft.com/content/881b1ee9-4488-47de-a19f-40104d552e10?accessToken=zwAGJL3gYNBgkdOIGx7pRIhH3tOhn0AQTVUuEA.MEUCIFAKWqbrd4BDNRTINB9yC9-EnJ6ISO34zeJsvWlaqNPsAiEApQsiFkj981tsUMtWwigWxgX5lfUncpC8RwvIOdZwB78&sharetype=gift&token=c7da3dd8-3965-4ff3-8ef3-4844ecaa7116

¹² https://www.ft.com/content/dc565eac-2b18-47f8-8378-8818ac9c3eae